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Pros and Cons of Cash-Out Refinancing


Cash-out refinancing is an easy to understand form of borrowing. With cash-out refinancing, you refinance your current mortgage for more than what you owe and take the difference in cash. Say you owe $120,000 on a home worth $200,000; you could refinance the mortgage for $150,000, paying off the old mortgage with $120,000 while putting the additional $30,000 in your pocket.

Then, of course, you would start making payments on the $150,000 mortgage.

Why would you choose cash-out refinancing?

  • To make home improvements
  • To make major purchases
  • To pay for college, major medical expenses, etc.
  • To consolidate high interest rate debt (credit cards, auto loans, etc.)
  • To pay for a vacation or other luxury items
  • To help finance the purchase of other properties
  • To make other investments

While they may seem similar, cash-out refinancing is different from getting a home equity loan or a home equity line of credit. Both result in cash in your pocket, but:

  • A cash-out refinance loan is a new loan; it replaces your old mortgage and becomes your new "first" mortgage.
  • A home equity loan or line of credit is a separate loan; it becomes a "second mortgage," separate and distinct from your current or original mortgage.
  • Closing costs are required when you refinance a mortgage (although they may be somewhat lower than normal if you refinance your original mortgage using the same lender).
  • Home equity loans and lines of credit generally do not require closing costs; if closing costs are required, they are typically much lower than for a first mortgage.

Cash-Out Refinancing: The Pros

  • Cash out refinancing generates a lump sum you can use in any way you wish.
  • Qualifying for cash-out refinancing is typically easier; you already own the home and have established a payment history, and you owe less than what the home is worth (or else you would not qualify in the first place).
  • Interest rates for first mortgages are generally lower than for home equity loans or lines of credit.

Cash-Out Refinancing: The Cons

  • Closing costs are typically higher than for home equity loans or lines of credit.
  • Cash-out refinancing will cause you to "reset" your current mortgage, extending the term over which you must make payments on a mortgage (unless you refinance for a lower number of years, of course).
  • Borrowing more than 80% of the value of your home could require you to pay private mortgage insurance (PMI), potentially adding hundreds of dollars to your monthly payment.
  • You will probably not qualify for a cash-out refinance until you have lived in the home for at least a year (called "loan seasoning"). Until that time has passed you may not be able to refinance.

Here are a few simple scenarios that might help you decide whether cash-out refinancing is right for you:

  • If interest rates are lower than for your current mortgage, a cash-out refinance could put money in your pocket and lower your monthly payments − or at least keep your payment relatively flat.
  • If interest rates are higher, a cash-out refinance probably doesn't make sense. Choose a home equity loan or line of credit instead.
  • Even if interest rates are lower, consider the age of your current mortgage. If you have been making payments for ten years on a thirty-year mortgage, a significant portion of your monthly payment now goes to paying off principal instead of interest. Refinancing into a lower rate won't have as much impact, and your loan will be "reset," causing you in effect to turn what was a twenty-year mortgage into a thirty-year mortgage.
  • If you plan to use the funds over a number of years − like, for example, to pay for college − consider a home equity line of credit. That way you can withdraw money only when you need it and pay interest only on the amount withdrawn to date. With a cash-out refinance, you'll start paying interest on the entire amount immediately.
Personal – Homebuying and Refinancing

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This article contains general information only. Sunflower Bank is not, by means of this article, rendering accounting, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, before making any decisions related to these matters, you should consult a qualified professional advisor.